We learnt about Blue Ocean Strategy and Disruptive Innovation, which we often link them to technology based products/services. Here's an interesting article which brings in the coffee industry and how blue ocean strategy is created not once, but twice-with Starbucks and Nestle. And how at the end of the day, it's all about constant innovation that keeps you on track.


So the next time you drink your coffee, do think about it.

Lessons from service innovation in the coffee wars

Is coffee a drink? Or is it a service? The answer may seem obvious: coffee is a black powder onto which you pour hot water, or consume from a vending machine at the office, and is known to be mildly addictive; it comes in tins or vacuum packs and is supplied by a small number of international food companies. So it is clearly a product. And yet, an understanding of what else customers want when they consume coffee has led to a revolution in the coffee business. Reaching a similar level of understanding about customer needs and the transformative power of service innovation may yet revolutionise the business you are in.

The rise of Starbucks as a ‘game changer’ in the consumption of coffee is a well documented story and a favourite of business schools over the last decade. INSEAD’s Chan Kim, explains how the founders of Starbucks were the first to comprehend the full ‘value map’ of what the customer wanted from their ‘coffee experience’. By positioning a new business (upmarket coffee with superior service) where nobody else was competing, Starbucks created a new market segment (what Kim refers to as a “Blue Ocean”) and captured very profitable margins for itself. Innovating the product was only part of the story: Starbucks offered its customers a convenient and relaxing moment on their way to the office. Accompanying every cup of Caffè Latte was an even more significant recipe: service innovation.

The product management teams of Nestlé, based in Vevey Switzerland, had spent the 1980’s looking at coffee in a very different way. Sales of the market leading ‘Nescafé’ were stalling, and some significant coffee markets, such as Italy, refused to drink instant coffee despite decades of marketing investment. The Nescafé mentality was pure ‘Red Ocean’, as Professor Kim would tell us: a focus on how to promote a product through existing channels while attacking the competition head on. After decades of the instant coffee wars, nobody was thinking about service innovation before the Starbucks wave crashed onto the global retailing scene.

And yet, a possible answer to the challenge of Starbucks had already been invented within another division of the giant Swiss company. In 1976 Nestec, Nestlé’s development centre, patented a form of capsule containing freshly ground coffee and a pressurized process for coffee extraction. It took ten years before anybody got round to marketing it, at first to the slightly quirky Japanese and Swiss markets. Another ten years would go by before the ‘Nespresso’ concept was adequately worked out for other markets.

Since 1996 sales of Nespresso have more than tripled: it is now a very high margin billion Euro business. (Source of graph, Nestlé Investor Group Meeting, Decemer 1st 2006).

The product had not changed significantly since its invention, so what explains how Nestlé was finally able to turn Nespresso into a business that has enjoyed almost explosive growth? Superior marketing, and the support of George Clooney for sure, but more importantly a distribution and service concept in line with the up market positioning of the product. Over this latter period, the company opened boutique stores in key city centre locations around the world to sell machines, capsules and accessories to the high end consumer. Just as significantly, the company embraced the Internet, selling next day delivery of coffee capsules direct to members of the ‘Nespresso Club’ (who now number over 2.5 million).

The business of selling coffee has changed radically over the last ten years, driven by these new service concepts. Is the innovation over? It is not hard to find competitors for Starbucks and Nespresso, and each of them is adding their own form of innovation. McDonalds is now Germany’s leading coffee retail chain with over 500 ‘McCafé’ outlets around the country, and similar number elsewhere in Europe, which offer cappuccino and espresso with pastries adapted to the local market. Philips and Sara Lee set up a joint venture in 2001 to build the Senseo ‘coffee pod’ system. Senseo claims to fit in yet another new market space (somewhat different from Nespresso) a mass market proposition which Philips calls ‘café crema’. With more than 4 billion pods and 10 million machines sold since the launch of Senseo, it is clear that this ‘Blue Ocean’ is very wide as well as deep.

These businesses (with the exception of Starbucks which over-extended itself during the boom years) are showing particular resilience during the downturn. Both Nestlé and McDonalds were rare in producing 2008 results which exceeded analyst expectations. Maybe there is something about providing a unique and innovative customer experience, which keeps them coming even when times are tough.

How is the metaphor of innovation in coffee retail relevant to you in your business? Firstly there’s the story of Blue Ocean strategy: considering where no one else is adequately responding to customer needs and building an effective product and service position. Secondly, there is a lesson to be learned from companies who sell very physical products (food and burgers) but nevertheless consider service innovation to be absolutely essential to their continued success. Gerhard Berssenbrügge, CEO of Nespresso (quoted in Management Today in June 2006) "In real estate, it's location, location, location; here, it's innovation, innovation, innovation, on all fronts."

Extract from EFQM